PGMs: The baby went out with the bathwater

Within the commodity space, perhaps the most bullish fundamentals belong to the Platinum Group Metals (PGMs). Both platinum and palladium have similar industrial and commercial uses as well as demand growth, and both suffer from a less than secure supply. In our June 5 note entitled “Platinum: time to shine,” we espoused the bullish case for platinum, based on the potential for supply disruptions stemming from contract renegotiations in South Africa. We recommended a long position with a protective stop at $1.430 (basis July), which unfortunately did not hold in the face of a Fed-inspired selloff in gold that saw the yellow metal fall over $200, and which took the rest of the precious metals down with it. Fortunately, this has presented an opportunity to establish new long positions at more favorable prices.

The situation in South Africa is as perilous as ever. Last week an illegal wildcat strike shut down production at two of Anglo American Platinum’s (the world’s largest platinum producer) mines in the Rustenburg area. Workers have since returned to the mines; however, the incident is indicative of a heated atmosphere where unexpected labor actions can idle production at any moment.

Meanwhile, the two unions that dominate the mining industry are competing for members and trying to show their relative strength by playing hardball with the mining companies. At this summer’s annual labor negotiation’s kickoff, both unions made record demands on gold producers, with the NUM asking for as much as a 60% increase in pay and the upstart AMCU demanding that wages be doubled.

The unprecedented demands on gold producers are a clear sign that platinum producers will face similar pressure from unions. South Africa produces 73% of the world’s platinum and 36% of the world’s palladium. Meanwhile, on the other side of the globe the largest producer of palladium, Russia’s Norilsk Nickel, warned earlier this week that without new projects, the persistent deficit in palladium supply will double to 2 million troy ounces by 2020. The most recent Johnson Matthey report revealed that while new supplies of palladium were just 6.5 million ounces in 2012, demand reached 7.6 million ounces – and demand is starting to pick up.

The most important use of the PGMs is in autocatalytic converters, which reduce the pollution in emissions from vehicles. With the economy starting to recover in North America, and the Chinese automobile market now the third-largest consumer of PGMs, demand is only going to rise, since no economically viable alternative to PGM use in autocatalytic converters has yet to be found. Beyond the growth in the absolute number of cars built, it is the move towards stricter emission standards that will drive demand higher. Last year, while Chinese car sales grew only 5.2%, palladium and platinum demand grew 11% and 10%, respectively, due to the implementation of China 4 emission standards.

The final wildcard to the PGMs is investment demand, which has been brisk. Charts 1 and 2 show the inflows into physically-backed ETFs for both metals, and demand for platinum has been particularly strong. It’s no wonder investors are flocking to the PGMs, which have outperformed the more traditional precious metals (gold and silver) by a wide margin over the past several months (Chart 3).

The risk remains that another leg lower in the gold market could drag the PGMs down with it; however, at current prices both represent good value and stand out as rare bastions of fundamental strength in an otherwise lackluster market for commodities.